We have a normal economic calendar, but a very short week. Many market participants will head for home early on Wednesday for an extended weekend. Some will skip this week entirely. We’ll have interesting data on housing, sentiment, and leading indicators, all reported in a three-day period. The prediction for Friday is easy. The annual Black Friday coverage will take center stage. With these sales starting earlier and earlier, I expect the pundits to join earlier as well. They will be asking: Will holiday shopping provide a needed economic boost?

Last Week Recap

In my last edition of WTWA I guessed that the stock rebound from the lows would have the punditry wondering if the market storm had been averted. With Monday’s decline of about 2%, that question did not last long. Even small news tidbits about tariffs seemed to have a significant intra-day effect.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. This week I am featuring Jill Mislinski. She includes a lot of relevant information in a single picture – worth more than a thousand words. Read the full post for more great charts and background analysis.

The market lost 1.6% and the weekly trading range was 3.8%. I summarize actual and implied volatility each week in our Indicator Snapshot section below. Let’s also check in on the history of drawdowns. [Some readers have inquired about the percentages in this chart. The YTD seems to be based upon the closing price of the first day of trading in 2018. The other callouts show daily changes and the Friday range. The volume bars are also helpful. It is a lot of information in one chart].

Personal Notes

I had a chance to discuss my approach, background, and interactions with investors in a podcast interview this week with Gil Weinreich. Readers who have never spoken with me might want to find out what I sound like.

I will be in the office this week, but plan to spend evenings and Thanksgiving with Mrs. OldProf and family. I thank all my readers, especially those who have commented, encouraged, and made suggestions over the last year. It is a time of turbulence and special distress for many, but we have much to be thankful for.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too.

New Deal Democrat’s high frequency indicators are an important part of our regular research. This week reflects further softening in the long leading indicators, which have turned negative. NDD takes note of the effect of tariffs. He is not on his one-year recession watch, pending further and persistent weakness.

When relevant, I include expectations (E) and the prior reading (P).

The Good

• Earnings season (with reports in from 92% of the S&P 500 companies) has been excellent on nearly all fronts. John Butters (FactSet) summarizes his “Key Metrics.” The entire report is loaded with valuable information.

  Earnings Scorecard:

  For Q3 2018 (with 92% of the companies in the S&P 500 reporting actual results for the quarter), 78%

  of S&P 500 companies have reported a positive EPS surprise and 61% have reported a positive sales surprise.

Earnings Growth:

For Q3 2018, the blended earnings growth rate for the S&P 500 is 25.7%. If 25.7% is the actual growth

rate for the quarter, it will mark the highest earnings growth since Q3 2010.

Earnings Revisions:

On September 30, the estimated earnings growth rate for Q3 2018 was 19.3%. All eleven sectors have

higher growth rates today (compared to September 30) due to positive EPS surprises and upward revisions to EPS estimates.

Earnings Guidance:

For Q4 2018, 61 S&P 500 companies have issued negative EPS guidance and 27 S&P 500 companies

have issued positive EPS guidance.

Valuation:

The forward 12-month P/E ratio for the S&P 500 is 15.6. This P/E ratio is below the 5-year average (16.4) but

above the 10-year average (14.5).

He also notes that companies have not been rewarded for good results but have been punished for misses.

• Retail sales increased 0.8%. P -0.1% revised from a gain of 0.1%. E 0.5%. Jill Mislinski looks at the longer history of this series, including several interesting charts. Here is a good example.

• Sentiment turns bearish, a contrary indicator. Last week we illustrated individual sentiment. This week David Templeton (HORAN) highlights the low exposure of the National Association of Active Investment Managers (NAAIM). He observes that the exposure level is near that of the 2016 low. Having attended their conference last week, I can personally confirm his conclusions.

The Bad

• Philly Fed registered 12.9 P 22.2 E 20.5. I am including this since a recent academic article showed that the report can move markets. Hardly anyone knows the sample size or how it is chosen. No one knows the margin of error. Few understand how to interpret a diffusion index. It is just another number that people chart and compare to prior readings. In that view, lower means a slower pace of growth and is therefore bad.
• NFIB small business optimism declined to 107.4 P 107.9 E 108. I am scoring this as “bad” because of my rules on prior readings and expectations. David Templeton (HORAN) points out that the report was still strong, down only slightly from the 45-year high from August. See his report for more detail on the relevant components.

• Industrial production increased only 0.1% E 0.3% P 0.2% revised down from 0.3%.
  Steven Hansen (GEI) takes his customary deep dive, looking at moving averages and year-over-year data, as well as the upward revisions.
• Initial jobless claims increased to 216K E and P 214K.
• Brexit turmoil creates both uncertainty and another threat to global growth. (The Economist). There is criticism of Prime Minister May’s plan from all sides.

The Ugly

Wildfires. Not only larger, but different in character. Fast-moving and destroying large swaths of territory. The loss of life and property is correspondingly higher. One mission is to provide as much help, as quickly as possible. Later there will be time to ponder needed changes in public policy.

Google has an interactive update map. Here is the current picture, for those who may not realize the scope.

The Calendar

The calendar is normal but compressed into a short week. Important housing data will be of the greatest interest. A decline is expected in the leading indicators, which will probably attract comment. Michigan sentiment is expected to remain stable.

Despite the holiday week, we’ll no doubt see some tweeting and political posturing. Too bad we can’t have a national “quiet day.”

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

I expect the punditry to be short-staffed and geared up to discuss shopping. It is another topic where everyone can claim to be an expert, and it does have important economic consequences. Expect plenty of chatter (and the obligatory mall visits) asking: Will shoppers provide an economic boost?

I have no special expertise or sources on this. Retail sales were good last month. Wages are moving a bit higher and employment is good. Sentiment is high. These would seem to suggest good numbers. “Davidson” (via Todd Sullivan) provides some data, concluding as follows:

It makes sense that when consumer incomes slow that they will spend less and this should eventually lead to a recession when companies suddenly realize they have over-staffed for business which did not materialize.

Inspire of the loud, very loud shouting of a pending economic collapse by CNBC anchors and well known billionaire investors (actually they are Momentum Traders), the economic data indicates all will be surprised to the upside.

Very good time to buy stocks!!

Once again it is not really the best question for us to consider. Here is a summary of what I see as the most important issues. Sticking with my recent approach, I’ll put my own reactions in italics.

Economic Growth

The conventional wisdom is that the business cycle is aging, late-cycle, or long in the tooth. Pick your favorite description. It has reached the point where you hardly even see a contrary viewpoint – except from the Fed.

On Friday, Cramer attempted a reprise of his 2007 rant. (Watch the video here). The pundit-in-chief assured us that he was smarter, more experienced, and had better information than the Fed. The current membership should “do more homework” by talking to companies. They were youngsters who might have been employees if he had hired them. He is older and wiser, so they should listen. He also endorses Trump’s tariff policy, placing the blame squarely on the Fed, but he believes the Fed should still raise rates next month. Got it?

CNBC pitched the Cramer comments throughout the day.

Cramer sometimes provides good information in his interviews with executives. From these experiences and his reading, he knows a little bit about a lot of issues.

Does he have “special information?” This would suggest that executives are telling him non-public information. He claims that they are urging him to “speak out.” He highlights his 2007 rant claiming he is ahead of the Fed 1-0. He never mentions his erroneous 1998 call where he forecast a 1987-style crash. Those posts seem to have disappeared. If Cramer really wanted to help people – either in 2007 or now – he would provide an organized, logical presentation that included some evidence. If he wants to be taken seriously, he must persuade, not put on an act.

As to the Fed – Their staff of 350 economists and data resources provide more information than CNBC. They include anecdotal information of the Cramer style in the Beige Book for each FOMC meeting.

Here is the big difference: Cramer starts with a viewpoint and then cherry-picks specific companies as evidence. The Fed begins with data.

Here are some examples pitched to demonstrate the postulated economic weakness.

Here are some examples pitched to demonstrate the postulated economic weakness.

• Apple (AAPL). The supplier information is a harbinger of global economic weakness.

  Even if the news was a negative for iPhone sales, what reasoning takes us to a global inference. If you missed my post on this topic, please check it out – The Costly Craving for Reasons.

• Nvidia (NVDA). A disaster. Can we even trust them anymore?

  Much of this story is about reduced bitcoin mining, lower demand for graphics processors. Is this relevant to most other chip stocks? The global economy? (FT).

• Pulte Homes (PHM). Proof that housing has collapsed.

  Why pick Pulte? Lennar (LEN) beat on earnings and revenues and showed confidence in the outlook. Cramer and the team are using the market reaction to prove that something is wrong. Instead, they should be using data to evaluate the market move, finding good opportunities for their viewers.

• Oil Prices. Proof of a collapse in worldwide demand.

  Old models view commodity prices as an indicator of worldwide demand. Those who (proudly) did not take Econ 101 do not understand that prices are the intersection of supply and demand curves. The current price pressure is almost entirely a question of supply.

  For comparison, here is the data-driven conclusion of Dr. Robert Dieli, the leading business cycle expert. Following the business cycle helps investors avoid the crucial mistake of sitting out big rallies, as many have for the last seven years or so. The chart below is but one summary page of his regular detailed report.

  

 

Trade Policy

This remains as the most important economic issue. Some believe that talks in advance of G20 suggest possible grounds for a China deal – or at least the outlines of one. The daily media suggest that there is a “globalist” faction (Mnuchin, Kudlow) and a “nationalist” faction (mostly Navarro). Recent stories seem to hint at progress for the globalists, but the news changes daily. No one really knows. David Kotok has an upbeat view on the prospects.

I did not expect progress before the election. There was nothing that would really “score” as a big victory. Staying to a hard line was better. It is now possible to have a reasonable step that Trump can use to declare victory. I am sure that the internal GOP pressures from supporters are increasing – part of the real-time lesson in economics.

If there was some kind of definitive China agreement, the market could pop by 15% or so. Economically sensitive, out-of-favor stocks would do much better. Why do I conclude this? I watch news and daily price movements in specific sectors. It is a useful area of expertise.

Earnings

There is a great debate about earnings expectations, including several of our respected sources.

• Urban Carmel believes that the 2019 earnings outlook is “far too optimistic.” He has a list of concerns including continuing dollar strength and pressure on margins. He does emphasize that stock gains so far have been mostly driven by better earnings.
• Dr. Ed Yardeni sees 2019 analyst estimates as “too high.” He describes this as a consistent pattern, despite recent deviations. His own 2019 estimate is 177.69, close to what I have been using. Here is his key chart:

Brian Gilmartin is not making any assumptions about the underlying variables. He carefully tracks the changes in earnings estimates. This week he shares information about the “Top 10” in the S&P 500 – about 22% of the overall market cap. Read his full post for plenty of data. Here is his basic conclusion:

22% of the SP 500’s market cap is telling you – as of 6 weeks into the correction – that 2019 doesn’t look that bad in terms of 2019 EPS trends. Could that change from here? Sure, the trends could reverse or accelerate to the downside, but look at the headlines relative to the EPS trends. Also, 2019 could be another year of P.E compression as this blog discussed last week.

I am surprised at Ed’s chart, which seems to provide a biased emphasis. On first look, it seems like a big earnings decline. Actually, it is a lower percentage increase. Also, the squiggles start long before the final result for the quarter. I wish more people would emphasize the forecasts a year ahead. That is what I use, and it is much better.

Urban Carmel has an opinion based upon certain assumptions, some of which are surprising. Dollar strength, for example, he cites as a recent shift. Anyone using the prior trend would have been wrong. Why the confidence that we should project further strength? The profit margin theme is very old and deserving of independent study.

I am keeping a close eye on Brian’s numbers. I regard forward earnings estimates as important, mostly because that is what investors use when they are actually trading stocks! It seems so simple, yet so few agree.

Today’s Final Thought will focus on implications for investors.

Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Short-term trading conditions remain at high alert. The identification as “very bearish” is a reaction to volatility, not a prediciton of market movement. There is always a risk/reward balance to consider in your trading. When conditions are technically challenged, we watch trading positions even more closely. Each of our models has a specific exit strategy. The technical health rating may drop enough for a complete trading exit. It got close to that level recently.

Long-term trading has improved a notch on a technical basis despite this week’s market decline.

Fundamental analysis remains strongly bullish. Earnings are great, prices are lower, and there is even less competition from bonds. We reduce fundamental positions (as we did in 2011) when we get a warning from the recession or financial stress indicators, not merely as a reaction to technical signals.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.

Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession. Here is the latest chart on the Business Cycle Index.

Guest Commentary

Ugly Research asks, Are you quantamental? Should you be?
The combination of computing power and human expertise might be a winner. For example:

Within your industry, you can demonstrate how to set guard rails that help humans and machines overcome their worst decision-making instincts. What are the high-quality decision processes that reliably produce good results? Which decisions require no human touch, and which ones don’t benefit from extensive analytics? What should be escalated – and to what end? A quantamentalist knows what people know, interprets technical findings, and understands the significance of qualitative evidence. It’s a challenging role suitable for people who want to stay on the cutting edge.

Insight for Traders

Check out our weekly “Stock Exchange”. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week we highlighted trading opportunities in Brazil. As usual, we also shared advice by top trading experts and discussed some recent picks from our trading models. Our ringleader and editor, Blue Harbinger, provided fundamental counterpoint for the models, all of which are technically-based.

Insight for Investors

Investors should have a long-term horizon. They can often exploit trading volatility.

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Nick Maggiulli’s On Confidence and the God Complex. Starting with the case of Elizabeth Holmes, founder and CEO of the fraudulent blood-testing company Theranos. Looking into the reasons behind her ability to fool so many for so long, he suggests some general principles, which he distills into the God Complex.

You might think that I am talking about monotheism or polytheism, but I’m not.I am talking about the new Gods.The Elizabeth Holmeses, the LTCMs, the market pundits, the influencers.The ones who seem to divine the future, to do the impossible.Yes, these are the Gods of our times.How should I eat?How should I invest?How should I live?Find yourself a little God that tells you.It’s okay.It’s in your nature to crave this advice.As Jeff Gundlach stated in a recent interview:

People want to be told what to think.

There are several more great examples leading to the key conclusion, one that is completely in sync with my theme this week. Discussing a fake Warren Buffett account retweeted by many prominent people, he writes:

Why was it so contagious?  Because people just want simple answers.They want there to be a “10-step guide” to getting rich or “5 daily habits” to become successful.Though the truth is far messier, they will follow whoever gives them the easy path.I am not immune from this either.I have read lots of these lists because, maybe, just maybe, one of them will have an insight I hadn’t thought of before.

Read the full post for more examples and links to key sources.

Stock Ideas

Kirk Spano sees opportunity in oil. Check out the reasons for his enthusiasm, based on both fundamental and technical analysis of oil prices.

Continuing my series on boosting your dividend yield, I wrote about the consequences of losing your stock when the call you sold is exercised. Using JM Smuckers (SJM), one of my recent trades, I showed how this situation could still work well for those whose principal need is income.

Stone Fox Capital sees “too much skepticism” around Macy’s (M). Is this a good holiday shopping play?

Morningstar opines that It’s Time to Buy Tencent. (TCEHY)

Personal Finance

Gil Weinreich’s Asset Allocation Daily is consistently both interesting and informative. Each week he highlights stories of interest for both advisors and investors. He also provides insightful commentary on important topics. Be prepared for something that cuts against the grain!

My favorite this week, naturally , had to be the episode where I enjoyed a podcast discussion with him. In another post he took center stage in analyzing the problems of millennials, student debt, and possible help from innovation in 401K’s. Abbott has adopted this approach, partly to improve worker retention. While applauding the basic idea, he also emphasizes that workers cannot count on a corporation they way they could Mom and Dad. This is an important issue – worth thinking about for family members of all ages.

Abnormal Returns is an important daily source for all of us following investment news. I read it religiously. His Wednesday Personal Finance Post is especially helpful for individual investors. As always, this week there are several great choices. My favorite was Richard Quinn’s (HumbleDollar) post, Clueless. After analyzing the poor records of celebrities who once had big bucks and some good sources on financial literacy, he concludes:

Where does all this leave us? We have a population that’s poorly educated in financial and economic matters, older workers who are ill-prepared for retirement, a younger generation saddled with student loans and finding it difficult to control their spending, and a retired generation calling for higher Social Security benefits.

A bailout would seem to be in order. But who’s going to do the bailing?

Watch out for…

Dillard’s (DDS). Too inconsistent, concludes D.M. Martins Research.

Bespoke warns, Friends Don’t Let Friends Buy Leveraged ETFs. Check out the post for the usual great charts and analysis.

Final Thought

For starters, I intentionally omitted the Fed as a key issue. The notion that stock market gains are purely a result of Fed policy is wrong-headed. The Fed can normalize policy at a reasonable pace without a significant market impact.

How should investors deal with the key issues I identified?

1. Cramer vs. the Fed. If you are reading this, you probably do not need my help! But let me summarize.

   1. If you believe the market knows more about the future state of the economy, prepare for a perpetual chase where you are buying high and selling low. Check out Cramer’s record.
   2. If you are a buy-and-hold investor and are disturbed by recent market declines, your stock position is too big. The recent moves are well within normal fluctuations for a healthy market.
   3. If you are a data-driven investor with an understanding of what stocks are worth, this is a time of opportunity. Go shopping for stocks that are on sale due to irrational fears. Don’t worry about the emotional verdict of Mr. Market.
2. Trade issues. These are important, but nearly impossible to anticipate. If you get a sign that the globalists are gaining sway, be sure you are fully loaded.
3. Earnings. I am comfortable with the estimates for the next twelve months. It is the time of year where many quit thinking about 2018 and start using 2019 in their multiples. Yes, this is a foolish method, but a common one. I need to write more on this topic, and I will. It is too big for a WTWA post.

In summary:Do not be seduced by stories. Insist on Data. Accept no substitutes. [If you are confused about the current market and your portfolio, you might want to request some of my papers for individual investors. Or even a complimentary portfolio consultation. Just send an email to main at newarc dot com]

I’m more worried about:

• The continuing effect of the trade war. As I have often noted, it is a real-time econ lesson. The effects are more obvious each week – lower growth, higher inflation.
• The debt ceiling. Normally the party in power takes responsibility. This time?

I’m less worried about:

• The Fed. Despite the general rhetoric, the individual statements show awareness of the current situation and potential challenges.